What is the Rule of 40 in a startup?
The Rule of 40 is one of the most important metrics for mature startups, especially in the SaaS sector. It shows whether a company is growing in a healthy and sustainable way.
The formula is simple:
Rule of 40 = annual revenue growth (%) + operating margin (%) ≥ 40%
👉 Examples:
- A startup grows 30% annually and has a 10% margin – it meets the Rule of 40.
- A company generates 5% growth but has a 35% margin – it also meets the condition.
It is this simplicity and universality that have made the Rule of 40 a financial gold standard in SaaS.
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The origins of the Rule of 40
Although it is widely used today, the Rule of 40 only gained popularity in 2019–2020, at the beginning as the metric for startups. This was a period of declining scale of venture capital investments and growing macroeconomic uncertainty. Investors began to expect not only rapid growth but also profitability. The Rule of 40 thus became a simple benchmark that quickly took hold in the SaaS world and later spread to other industries.
Why is the Rule of 40 so important for startups?
At the early stages (seed, Series A, B), growth dynamics are what matter most. However, at Series C, D, and beyond, investors start asking for more:
- Is the growth efficient, and not just “bought” with burned capital?
- Can the startup combine expansion with profitability?
- Is the business model scalable and mature?
Therefore, startups that meet the Rule of 40 are:
- more attractive to global investors,
- more resilient to economic slowdowns,
- natural candidates for an IPO or acquisition.
What’s more, the Rule of 40 is not limited to SaaS. Private equity funds also use it when evaluating e-commerce or service companies.
Rule of 40 as a strategic tool
The Rule of 40 is not just a metric for investors. It is also a strategic compass for founders, forcing them to decide:
- whether to pursue aggressive growth (at the cost of losses),
- or to build stable profitability (at the cost of slower expansion).
Edge cases in the Rule of 40
- Very fast growth, low margin – risk of burning through cash.
- High margin, low growth – a stable business, but with limited momentum.
- Ideal balance – e.g., 20% revenue growth and 20% operating margin.
Thanks to this, startups can better define their priorities and adjust their strategy to the market.
How to interpret Rule of 40 results?
The interpretation of the metric is as follows:
- > 40% – a very good result, a signal of business health and maturity.
- < 40% – room for optimization (costs, revenues, strategy).
It’s not only about whether the company crosses the threshold, but also what drives the result:
- if mainly growth → investors will expect improved profitability,
- if mainly margin → the market may push for faster expansion.
This makes the Rule of 40 not just a metric, but a tool for making strategic decisions.
The role of controlling in achieving the Rule of 40
At the Series D stage, financial controlling is no longer just about reporting – it becomes strategic analysis. Mature startups use controlling to:
- analyze P&L in detail,
- identify levers to improve margin and growth,
- increase sales and marketing efficiency,
- optimize operating costs.
Rule of 40 for younger startups as well
Although the Rule of 40 is most often mentioned in the context of Series D, the metric also makes sense at earlier stages. Founders can use it to decide whether to reinvest profits for faster growth or build stable profitability. This makes the Rule of 40 a universal tool for managing a startup’s finances.
Summary
The Rule of 40 is one of the most important financial metrics for tech companies, SaaS businesses, and late-stage ventures. It combines growth rate and profitability, showing whether the business is developing in a healthy and efficient way.
Thanks to its simplicity and universality, it has become a global standard. It should be seen not only as a financial KPI but also as a strategic tool that helps founders find the right balance between scaling and stability.
At incro, we help founders and CFOs prepare for exits by strengthening financial operations, streamlining reporting, and improving business performance. We act like your internal finance team – without the cost of full-time hires.
💬 Get in touch at https://incro.us/contact/
